If transition management has taken time to establish itself in the pensions world, it remains very much in its infancy in the defined contribution sector.

DC didn’t warrant a mention when the National Association of Pension Funds produced its guidance on transition management last year, and it’s not just trustees and scheme sponsors that are overlooking it. Managers too have traditionally focused purely on the big final-salary schemes.

But the industry is starting to change. Three years ago, Mercer didn’t oversee the appointment of a single transition manager to DC schemes; last year, they made up about 15% of appointments. Gunnee said: “It’s still small, but it is growing.”

There are several reasons for the greater involvement of transition managers. Many of the drivers for increased interest in transition management apply equally to the DC market: greater volatility and the aftermath of the crisis prompting reviews; and the increasing use of a wider range of more complex, and often less liquid, assets that mean trustees are more likely to look for specialist help.

Auto-enrolment, which from next year will see larger companies obliged to sign workers up to their pension scheme unless they opt out, means a number are looking at their pension arrangements. They are asking whether they could get a better deal as their schemes see more money going in, and examining whether default funds remain suitable for a new membership profile.

John Lawson, head of pensions policy at Standard Life, said: “Large employers have really woken up to the issues and are making changes to cope. They are beginning to think about this a lot more carefully.”
These changes are underpinned by a trend that is also driving interest in transition management on the DC side – the schemes are getting bigger.

There are not always opportunities for transition managers to get involved. For example, there is little need for a transition manager where schemes are shifting from one investment platform provider to another without changing the underlying funds. However, the case for having one is stronger where the move is between segregated funds and pooled funds, or where schemes use the opportunity to not just switch platforms but change some of the fund managers or introduce new funds.

In the past, DC schemes have been happy to handle that by simply cashing in members’ investments and buying into the new funds. Since the sums involved were small, they didn’t worry too much about the costs incurred as a result of the spreads or the time out of the market.

Mark Dwyer, managing director and head of Emea for Mellon Transition and Beta Management Services, said: “When the asset pools were small those costs were relatively insignificant. With bigger pots, they’re much more significant.”

Gunnee believes hiring a transition manager is only cost-effective for transfers of £50m or more.
The goals for transferring funds to DC schemes are largely the same as they are for any transition – to reduce the costs and risks of the move, while increasing transparency. The tools employed are similar too, with reregistration, pre-funding and in specie transfers all used to achieve those ends.

Simon Foster, head of Zurich Corporate Pensions in the UK, said: “A lot of the underlying principles and techniques are very similar.”

However, the DC market carries challenges. While the increasing number of segregated DC accounts is one of the factors that has helped promote the use of transition management, pooled funds continue to dominate. That means managing cash exposure, rather than trading securities, is often the key skill for transition managers on the DC side.

More importantly, DC schemes’ structures are unitised, made up of hundreds or thousands of individual members’ accounts.

Managers have to ensure allocations at the unit level are correct for each member and members are treated equally in terms of the costs incurred from the move. Funds that could be co-mingled in a defined benefit transition may require separate accounts, and trustees will have to consider “blackout periods” during which members are prevented from making changes to their funds. It all adds significantly to the complexity and administrative burden of such transitions. Chris Adolph, head of transition management for Emea at Russell Investments, said: “There are a lot more moving parts on the DC side.”

Whether that means managers from a custodian background are better placed to handle transitions for DC pensions, as some suggest, is debatable. However, it does mean that trading desk expertise alone isn’t enough. Andy Cheseldine, a principal in the DC services team at consultant LCP, said: “Robust project planning is the key on the DC side.”

He believes communication with scheme members is particularly important, especially when handling black-outs.

Whether transition managers are ready for such challenges is another question, according to consultants. Michael Gardner, Emea head of transition management at JP Morgan Worldwide Securities Services, believes increasing complexity on the defined benefit side has seen managers bolster their project management skills, leaving them better placed to tackle DC transitions.

He said: “Our business has been getting more complex over the years anyway. Long gone are the days where it was simply about selling one manager to buy another.” He has argued that there are “vast opportunities” in the DC market for transition managers.

Edward Pennings, who runs State Street’s transition management business, said many of the skills learned on defined benefit schemes were transferable. He said: “In any case, any lack of experience on the DC side won’t be a problem for long.”

As final salary schemes continue to move towards their end game and DC funds grow and mature, the demand for transition management from trustees and sponsors and the attention given to it by the managers will increase.

Penning said: “DC isn’t just where the future lies for transition management. It’s where the future lies for the pension fund industry.”

• NAPF guide steers schemes through transitions

Last year, the National Association of Pension Funds published a guide: Transition Management Made Simple. Although it does not discuss defined contribution transitions directly, many of the principles discussed apply, according to David McCourt, NAPF senior policy adviser.

As the guide sets out, transitions occur whenever a scheme restructuring takes place, and transition management makes sure it is done in a timely, risk-controlled and cost-effective way.
McCourt said: “A transition manager usually acts as a sort of warehouse provider and makes sure the transition from one manager to another goes smoothly.”

Various events might trigger a transition, and they can be grouped into two broad categories: one-sided events – creating portfolios from cash funding or liquidating funds to cash; and two-sided events, such as a change in fund manager, asset allocation or performance benchmark, or a pension scheme merger.
These events happen fairly infrequently, according to the guide, so pension funds are unlikely to have the expertise in-house, and this is the primary driver for using transition managers.

Interest has also been prompted by discussions around the development of the T-Charter, the industry code of best practice. Among the attributes pensions funds should look for are trading capability, project management expertise, robust risk management, clear analysis and reporting, and transparency on both transactions and fees.

McCourt said there had been few enquiries so far from its DC schemes about transition management.
However, that is likely to change and the market will grow, not least with the advent of the National Employment Savings Trust.